Articles Posted inPolicy Terms

On Tuesday, I was privileged to be part of a panel discussing cyberinsurance for public pension funds at Kessler Topaz’s Evolving Fiduciary Obligations for Institutional Investors conference, joining Victoria Hale, General Counsel of the Denver Employees Retirement Plan, and pension attorney Chris Waddell. We emphasized that the cyberinsurance procurement process is unique as compared to the renewal of traditional lines. The coverage is highly negotiable and definitely not one-size-fits-all. Here are a few pension-fund specific tips.

First, make sure intentional employee misconduct is covered. Insider misuse is among the most prevalent causes of data breaches for financial and public institutions. Yet, because cyberinsurance forms largely trace their roots back to commercial general liability policies, some of them still contain the traditional ‘intentional acts’ exclusion that bars coverage for an insured’s intentional misconduct. To make sure that your policy covers one of the most common breach causes, push back on this exclusion. Carriers will typically agree to a carve-out for ‘rogue employees,’ or will limit the definition of “insured” to employees only when acting within their scopes of employment. Either should leave coverage in tact when employees purposefully misbehave.

Second, be wary of cyber-endorsements to E&O and D&O policies. These endorsements are presented as low-cost alternatives to stand-alone cyberinsurance, but, as I covered here, you may be purchasing dangerously limited coverage. Many of these endorsements cover only third party risks – i.e., the class action lawsuit filed by individuals whose data has been compromised. This is likely not the most significant risk faced by funds. In fact, the most expensive elements of a data breach for public and financial institutions are legal advice for breach notification, forensic IT work to identify the problem and fix it and the breach notification itself, which generally costs $2-3 per notice recipient. Cyber-endorsements can be inexpensive, but they are only valuable if they contain an appropriate mix of first and third party coverages, the former of which must include breach coaching, IT response and breach notification.

There have been relatively few confirmed cyber attacks resulting in substantial physical harm to property (other than computer hardware) and people. The first known event involved the 2008-2010 infiltration of a computer virus called “Stuxnet” into Iranian networks that controlled nuclear subterfuges. The virus caused them to spin out of control, destroying about 20% of them. Another involved a hacking attack on a German steel mill in 2014, causing a blast furnace to malfunction and resulting in massive damage. Last year, an Iranian petrochemical company suffered a series of fires and explosions believed to have been caused by a hacking attack. And for each of these types of events, there have been innumerable other attacks on that could have but did not result in physical harm.

While underwriters still struggle to accurately quantify this risk, there is an increased willingness to enter the cyber-physical coverage market in different, and sometimes fairly creative, ways. But this risk doesn’t only impact cyber-coverage. Cyber-physical attacks can have enormous consequences, with damages likely to exponentially exceed the coverage provided by these new products. These attacks can be coordinated across multiple geographic regions, they can impact many people and businesses across numerous economic sectors and they appear to be easier than ever to anonymously effectuate.

The increased ease with which these attacks can be carried out coupled with the unprecedented level of harm they can cause requires likely targets to carefully explore the cyber-physical risk market. These circumstances, however, also require renewed consideration of traditional coverages by those who may be impacted downstream and by those who might find themselves defendants when even cyber-physical coverage purchased by the targets of these attacks proves woefully insufficient in light of the extent of harm. In fact, there are likely few companies that don’t need to revisit their entire insurance programs in light of the emerging cyber-physical risk. Consider whether coverages and limits are still appropriate for cyber and traditional coverages. This will get physical.

Stand-alone cyberinsurance is a critical component of enterprise risk management. But even companies with traditional and cyber coverage may, and usually do, have gaps in coverage created by what I’ve referred to as the ‘hot potato’ problem. This is when neither the cyber policy nor the relevant traditional coverage is truly designed for a relatively new kind of risk.

One example is physical damage caused by cyber events. Particularly as the Internet of Things increases the connectivity of physical devices, cyber attacks can hurt people and property. Cyberinsurance likely covers network security failures and unauthorized access to these devices, but ‘standard’ cyber policies typically exclude coverage when these events result in physical damage. And property and casualty policies that would otherwise cover physical harm generally exclude damages arising out of cyber events. Rock, meet hard place.

Gap, meet AIG’s Cyber Edge products. These products are designed to fill this gap by, in addition to covering the relatively standard range of cyber risks, including the ability to add coverage for cyber events that cause physical damage to people or property.

This article was first published in the Fall 2016 issue of “The Bulletin,” a quarterly newsletter published by Kessler Topaz Meltzer & Check, a renowned law firm representing institutional investors and classes in securities, shareholder and other complex litigation. I’ve included the full publication on my Resources page.

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Find me a centralized repository of personal, financial and health information, and I will find you millions of attempts per day to access, steal or corrupt it. Even absent a malicious actor, there is an increasing likelihood that private data will be inadvertently made public. This is our world.

Stockman addresses a coverage issue I’ve noted in cyber policies across carriers. They tend to say something like: “The Company shall not be liable for Loss on account of any Claim or for any Expense…for bodily injury…or damage to or destruction of any tangible property.” Carrier’s position: If the data breach or malware attack causes an explosion, that’s on somebody else. My take – well, it would depend on the facts, the policy wording and the state of the law in the relevant jurisdiction. Of course.

It’s now clear, however, that cyber attacks can do more than corrupt and steal electronic data. Cyber attacks can also result in machine malfunctions that cause physical harm ‘IRL,” or “in real life.” Consider a hacker taking control of an HVAC system, or a car or a nuclear centrifuge (it separates uranium isotopes to make nuclear bombs). The result: IRL, broken stuff, injured people damage.

Here is how it is supposed to work. Something bad happens. You’re insurance company pays for it. Then, your carrier sues the bad guy who harmed you. That’s subrogation.

In the data breach context, this timeless construct presents numerous challenges. The most notable is the difficulty associated with finding the bad guys. But that isn’t your problem.

The contract you have with your data hosting service, credit card processor or other vendor, on the other hand, might very much be your problem. You probably pay a monthly fee. Depending on the size of your company, that fee is probably a modest amount. For smaller organizations, it might only be $20 or so per month. Now, consider what this vendor is holding – all of your data. Yikes.

Cyberinsurance policies typically provide first and third party coverage. First party coverage relates to an insured’s own expenses in investigating and remediating a data breach, and recovering the insured’s data and other information assets. Third party coverage kicks in when customers and regulators seek to hold the insured accountable for the breach.

But we know this already, right?

We also know that underwriters started with commercial general liability (CGL) forms when they started writing cyber policies because, well, it was the closest thing they had on file and nobody likes to start from scratch. I’ve previously discussed how this has led to some CGL provisions spilling into cyber policies even though they really don’t belong. The contractual liability exclusion, the acts of war/terror exclusions, etc.

On May 31, 2016, the U.S. District Court for the District of Arizona held that P.F. Chang’s obligation to pay its credit card processor nearly $2M following a 2014 data breach was contractual, and therefore not covered under its cyberinsurance policy. Ouch. Let’s back up.

In 2014, hackers posted the credit card numbers of 60,000 P.F. Chang’s customers on the internet. P.F. Chang’s had a Chubb cyberinsurance policy in place, for which it paid a $134,052.00 annual premium. Chubb paid P.F. Chang’s $1.7M in policy benefits to cover forensic investigation, litigation defense and other costs, but that was less than half of the cost of this breach.

Those new, old-school Air Jordans are retro cool (and I have them). Those new cyberinsurance retroactive dates – eh.

I blogged about retroactive dates here. Reminder: an insurance policy retroactive date is the day prior to which otherwise covered occurrences are not covered. In the first policy placed with a particular carrier, this will usually be the policy’s inception date as well. In my prior post, I discussed the problem of data breaches that occur prior to the retroactive date, but which are not discovered (and litigated, regulated, remediated etc.) until after that date. Since many data breaches are not immediately discovered, this sequence could seriously impact coverage, particularly for new entrants to the market.

Here’s another twist. What about the alleged “wrongful act” that purportedly caused the breach (the “occurrence” if you want to get technical about it)? A plaintiff or regulator may contend that the “wrongful act” was the failure to implement particular security measures, and that may have occurred years before the breach. If the policy ties the retroactive date to not only the “occurrence,” but also the”wrongful act” that did or allegedly caused it, double whammy. And because the wrongful act could be at least alleged to have occurred at any time, this language could be placing coverage determinations in the hands of plaintiffs and regulators. Dangerous.

Last week, the Fourth Circuit affirmed an Eastern District of Virginia ruling that Travelers had a duty to defend Portal Healthcare Solutions with respect to a class action data breach lawsuit filed after patients found their medical records online, sans permission. The opinion analyzed a commercial general liability policy (CGL), specifically the “publication” issue that was also at the forefront in the 2015 Sony Playstation coverage dispute. In Sony, a New York City trial court held that CGL carriers had no duty to defend a data breach class action, a ruling many saw as a sign that the days of finding data breach coverage in CGL policies was coming to an end. There have therefore been a number of commentators suggesting that Travelers is a pendulum swing in the other direction, a sign that the viability of data breach coverage under CGL policies remains.